For many people, being able to enjoy an early retirement is one of the ultimate rewards of a lifetime of hard work. The ability to travel, explore new hobbies, and spend more time with family — all while feeling secure and financially comfortable — is truly a worthwhile aspiration.
As many successful early retirees will report, achieving this goal actually begins decades earlier. It's only through years of thoughtful planning, discipline, and hard work, that some people will be able to reach the point where early retirement is truly obtainable.
Whether you're in your 40s and starting to think about retiring early, or in your 50s and ready to take the plunge, our comprehensive guide has everything you need to know to make informed decisions about your future. From assessing your finances and setting realistic goals, to navigating the complex landscape of Social Security and Medicare, we've got you covered. In this guide, we provide expert advice, tips, and resources to help you achieve a secure and fulfilling retirement lifestyle.
In this article you will learn:
- How to review your net worth when considering retirement
- How to review your potential income and expenses in retirement
- A few potential scenarios in retirement to think about
ASSESSING YOUR NET WORTH
If you want to determine if early retirement is a viable financial option for you, it's essential to evaluate your current net worth and projected net worth at retirement. With full insight into these factors, you can get a complete understanding of whether retiring sooner than planned is possible. Once you have a grasp of your total net worth, you can begin thinking about the various inflows and outflows that will impact it in your retirement income planning.
Defining Your Assets
The first step in calculating your net worth is defining your assets. When determining your total assets, it's best to stick with those items that can be easily converted to cash and are likely to hold their value and/or may even increase in value over time.
The list below shows those types of assets that are typically used to determine a person's net worth for retirement purposes:
- Cash on hand
- Retirement account balances (IRA, 401(k))
- Individually owned stocks, bonds, ETFs, mutual funds, etc.
- Real Estate Owned (besides primary residence)
Defining Your Liabilities
The second step in determining your net worth is defining your liabilities. Your liabilities should include any credit card debt, personal loans, any loans for which you're a co-signer, automotive/RV loans, and business loans. Don't forget to include any amounts you may owe on a mortgage, as well as any loans against your 401(k).
Your Net Worth
The third step is where you determine your net worth figure. Your net worth is determined by subtracting your total liabilities from your total assets. While your net worth figure does provide you with a basic picture of your current financial status, it's also helpful to consider the liquidity and the importance of the items included in your list.
If your overall net worth is high, it can be a great advantage. Nevertheless, if most of the assets that make up your wealth are illiquid such as real estate properties, stocks in private businesses or some annuities then those components may not effectively and conveniently cover your retirement needs. By analyzing your net worth, you can determine what assets you have in your arsenal to begin to start creating lifetime income in retirement.
INCOME AND EXPENSES IN RETIREMENT
Review Your Projected Retirement Income
What you can receive in terms of retirement income will depend upon how early you want to retire. Some retirement income streams such as social security benefits simply aren't available to those who want to retire in their 50s or earlier. Examples of typical income streams for retirees include:
- Work pensions
- Employer-sponsored retirement plans
- Investment accounts
- Rental income
- Social security benefits (requires eligibility)
- Part-time "fun" job
To achieve the dream of early retirement, it's important to plan ahead and decide which sources of income are available right away and which will be accessible later. It is also essential to factor in how much your incomes may go up or down over time. With careful consideration, you can make retirement come true sooner than expected! If you're not yet eligible for social security, you'll want to get in touch with the Social Security Administration. It is important to figure out what your projected social security benefits will be. You can claim Social Security benefits as early as 62, but your benefit increases 8% each year you delay collecting. It’s often best to wait to claim Social Security until age 70, assuming you don’t need the cash flow to boost your retirement income streams until then.
Conversely, if you have income from rental properties, as long as you keep the properties well-maintained, the likelihood that your rental income will stay the same or even increase may be an accurate assumption. Either way, your ability to stay on top of these types of investments is key to maximizing their return and mitigating any potential losses.
One critical factor to consider is determining how much monthly income you can generate from your investment accounts before Social Security kicks in. This is especially important if you plan to retire in your 50s or early 60s and don't yet qualify for Social Security benefits. Without a steady income stream, you may need to draw down your savings more quickly than anticipated, which could result in running out of money sooner than expected. To avoid this scenario, it's essential to calculate how much your investment accounts can generate in monthly income to supplement your retirement lifestyle.
There are many strategies retiree's can use to turn they investment accounts into monthly retirement income. Some of them include 4% rule, bucket approach, and a dynamic distribution strategy. A financial planner can help you estimate your monthly cash flow based on factors such as your portfolio's size, asset allocation, and expected rate of return. By doing this, you'll have a clear understanding of your financial situation and can plan accordingly for a smooth transition into early retirement.
Your Future Expenses
In some areas of your life, you may be able to save money simply from the act of retiring early. For example, there are costs to having a job. Each paycheck you pay 401K contributions, social security and Medicare tax that you will likely no longer be paying with your retirement income sources. You might also have less in clothing and gas. However, there are expenses that could go up such as travel, entertainment, and even dining.
A rule of thumb many people assume is that their retirement expenses will be 70% to 80% of their pre-retirement spending, but this is often not the case. With more free time and flexibility in retirement, there are many opportunities to spend money on new activities and experiences, such as travel or hobbies. As a result, it's important to consider the potential for higher expenses in retirement. This allows you to build a buffer into your retirement plan and ensure that your income sources can support your desired lifestyle.
By factoring in potential higher expenses, you can approach retirement with greater confidence and peace of mind.
Determining your health care strategy is one of the most important decisions of retiring early. If you decide to retire before becoming eligible for Medicare, it is essential that you plan ahead and factor in your estimated healthcare costs. For potential retirees who are not yet eligible for Medicare, there are several health care options to consider.
One option is to continue with an employer-sponsored health plan if available. In some cases, employers may offer retiree health benefits or continuation coverage through COBRA. This is only a good option if you are within a couple years of Medicare eligibility.
Alternatively, some early retirees may choose to enroll in a short-term health insurance plan to bridge the gap until they are eligible for Medicare. These plans typically provide coverage for a limited period, such as three to twelve months, and may be more affordable than traditional health insurance options.
Another option is to purchase individual health insurance on the open market or through a state-based health insurance exchange. The Health Insurance Marketplace established by the Affordable Care Act (ACA). The cost of ACA premiums is determined by several factors, including age, income, location, and the level of coverage chosen. According to a 2021 study by the Kaiser Family Foundation, the average monthly premium for a 60-year-old non-smoker in a mid-level silver plan was $788.
However, it's worth noting that this is just an average and that actual costs can vary widely depending on the factors mentioned above. Additionally, those with lower incomes may be eligible for cost-sharing reductions, which can reduce their out-of-pocket costs. It's important to carefully evaluate your health care needs and budget when choosing an ACA plan, as well as to compare plans from different insurers to find the best fit for your needs.
With the right plan and careful budgeting, it's possible to find affordable health insurance coverage in your late 50s through the ACA Marketplace.
In short, healthcare insurance for people in their late 50s or early 60s can be expensive. Those who opt for early retirement, yet don't have health insurance coverage, must budget and determine a plan for how they will get coverage.
For those that do decide to wait for retirement until they're eligible for Medicare, it's still important to determine how much you'll need to cover for your share of healthcare and prescription costs.
Everyone's list of expenses will vary, but some of the basic expenses that most people will need to address include:
- Food and other household expenses (e.g., internet, garbage service)
- Vehicle maintenance and insurance
- Property maintenance and insurance
- Property taxes
- Medical insurance
- Dental and vision care
- Life insurance premiums
- Recreation-especially in the younger years of retirement
It's also important to consider big-ticket items such as buying a new vehicle or two, completing major upgrades around the home such as a new HVAC system or roof, or expenses associated with a catastrophic health issue. It's important to consider the cost of providing for any dependents you may have in retirement as well.
Long-Term Care Costs
As time goes on, you may need to consider a long-term nursing home care plan. Long-term nursing home care is an important consideration for many retirees as they age. Unfortunately, this type of care is not typically covered by health insurance or Medicare. While Medicare may provide limited coverage for short-term nursing home stays, such as those needed for rehabilitation after a hospital stay, it does not cover the cost of ongoing nursing home care.
This means that retirees who require long-term nursing home care may need to pay for it out of pocket, which can be a significant financial burden. According to the Genworth Cost of Care Survey, the average cost of a private room in a nursing home was $8,821 per month in 2020. This can quickly deplete retirement savings and leave retirees without the resources they need to pay for other expenses, such as housing or daily living costs.
To avoid this scenario, it's important to plan for potential long-term care needs as part of your retirement planning. This may include purchasing long-term care insurance, setting aside savings specifically for long-term care, or exploring alternative care options, such as home health care.
By taking a proactive approach to long-term care planning, retirees can ensure they have the resources they need to cover their care needs and maintain a secure and fulfilling retirement lifestyle.
A REALISTIC PLAN FOR THE FUTURE
The transition from working life to retirement can be a significant adjustment for many people. While retirement is often seen as a time of leisure and relaxation, the sudden change in routine and sense of purpose can be challenging for some. Many people express surprise when they learn that the first year of retirement can be particularly difficult. After spending their entire lives working with a clear sense of purpose and direction, retirees must suddenly find meaning from another source when their career comes to an end.
To address these challenges, it's important for retirees to plan for the emotional and psychological aspects of retirement as well as the financial ones. This may involve identifying new interests or hobbies to pursue, volunteering, or staying engaged in social and intellectual activities. By finding meaningful ways to stay active and engaged, retirees can overcome the challenges of the first year of retirement and create a fulfilling and purposeful retirement lifestyle.
List of Questions To Ask Yourself:
- How will I find meaning and purpose in retirement without the structure and goals of my career?
- What new activities, hobbies, or interests can I pursue to keep me mentally and socially engaged in retirement?
- How will I maintain social connections and relationships after leaving the workplace?
- What impact will the loss of a regular work routine have on my mental health, and how can I maintain a sense of structure in my daily life?
- How will my relationship with my spouse or partner be impacted by spending more time together in retirement?
Can Your Plan Withstand External Forces?
There are many types of expenses and loss of income situations over which people have little or no control. As the saying goes, "Don't put all your eggs in one basket". You need to be diversified and conservative enough to withstand an economic downturn but still aggressive enough to make your money last the rest of your life. Conservatively, you should plan on living until 95. You also need to consider those expenses that are out of your control and how they would affect you if they rose significantly.
Are Your Figures Realistic?
No one can predict the future, and yes, it's impossible to account for every unexpected event. After all, that's why certain events are labeled "unexpected". That is why it is prudent to underestimate one's assets and income, while at the same time overestimating the expenses, economic losses, and future financial obligations that may affect you.
Five Year Out Pre-Retirement Checklist
If after arriving at conservative estimates, you remain comfortable and optimistic about your ability to successfully pull off early retirement, then your goal is likely within reach. Here is a checklist of items to review regularly to determine if you are ready for retirement:
- Evaluate your retirement savings to ensure you're on track to meet your goals.
- Develop a comprehensive retirement budget to estimate your monthly expenses and cash flow needs.
- Consider working with a financial planner to review your retirement plan and identify potential gaps or risks.
- Explore potential health care options and estimate your future health care costs.
- Review your Social Security benefits and develop a strategy for when to start claiming them.
- Consider your housing options and decide if you need to downsize or make any home modifications before retirement.
- Develop a plan for your retirement lifestyle, including potential hobbies, activities, and travel plans.
- Consider purchasing long-term care insurance or other coverage options to address potential future care needs.
- Evaluate your estate plan and update your will, power of attorney, and other documents as needed.
- Consider ways to stay engaged and socially connected in retirement, such as volunteering or joining community groups.
By completing these and other important tasks in the years leading up to retirement, you can better prepare for the financial, social, and emotional aspects of this new phase in your life.
When making major decisions, it is prudent to seek out objective advice from professionals who can provide an in-depth assessment of your plans from start to finish. A financial planner can aid you in determining what assets you have to work with, how to manage outstanding debt, and what income sources you have to work with.
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